Many homeowners find it helpful to refinance either to lower their interest rate or even to take cash out of their home’s equity. When you want to refinance a rental property, though, you have a few different requirements. Mortgages on rental properties have higher rates of default than those on owner-occupied properties which makes lenders have tougher requirements when you want to refinance your loan.
The tougher requirements include larger amounts of equity. Of course, the amount of equity you need depends on the type of loan you need.
Conventional Loan Equity Requirements
Conventional loans are those backed by Fannie Mae or Freddie Mac. Conventional loans are available for both owner-occupied and rental properties. If you want to refinance your conventional loan, the amount of equity you must have depends on the type of loan – rate/term or cash-out.
A rate/term refinance means that you refinance to lower your interest rate or change your loan’s term. You don’t take cash out of the home’s equity. This type of refinance holds a lower level of risk for lenders since you don’t increase your loan amount – you just change its terms. Fannie Mae requires you to have 25% equity in your home in order to refinance with a rate/term refinance.
A cash-out refinance, as the name suggests, means that you tap into the home’s equity. Conventional loans do allow you to take cash out of the home’s equity up to 75% of the home’s value. Here’s how that would work:
Let’s say your rental home is worth $300,000. You have a $200,000 loan outstanding on it. This leaves you with $100,000 in equity, but you can’t take all of that equity out of the home. The maximum loan amount that you can have is $225,000, which means you can get up to $25,000 cash in hand.
Alternative Loan Programs to Refinance Your Rental Property
You don’t have to use Fannie Mae/Freddie Mac financing to refinance your rental property. You have the option to get a loan from any lender available to you. This may include local banks, credit unions, or even online banks.
If you find a lender that offers ‘alternative programs,’ you’ll be subjected to different loan requirements; including the amount of equity you must have in the home. Typically, banks that write their own loans and keep the loans on their books have more forgiving guidelines, allowing you to refinance your rental property with less equity in it.
Compensating Factors Help you Qualify
One thing that all loan programs have in common is the need for compensating factors. Any time you need financing for a rental property, lenders are going to worry about risk. In order to offset this risk, you could provide any of the following qualifications:
- High credit score – Conventional loans require a 680 credit score, but a score over 700 could be a compensating factor
- Low debt ratio – The fewer debts you have outstanding at the time of application, the less likely you are to default on your loan, which could increase your chances of approval
- Stable employment/income – Lenders like to see stable employment and increasing income over the years
- Reserves on hand – Fannie Mae loans require investors to have reserves (assets) on hand when refinancing, but they can even be a compensating factor for a subprime loan
The idea is to lower your risk of default as much as possible when trying to refinance your rental property. We suggest that you shop around with at least three lenders to find the program, rates, and fees that are right for your loan program. This way you can make sure that you cover all of your bases and find the loan that requires the least amount of equity or at least the amount that you have so that you can refinance your rental home.